Eugene Linden
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Latest Musing

The Supreme Court's Own Goal on Climate Change

[This article appeared in Lawfare. It's long for a musing, but I think it's important that the public see just how shoddy was the majority reasoning in West Virginia v EPA]

In 1970, Sen. Roman Hruska of Nebraska achieved a dubious immortality when he argued that mediocrity deser...

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Fire & Flood
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Deep Past
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endangered animals
rapid climate change
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fragging

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The Ragged Edge of the World



Winds of Change
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Afterword to the softbound edition.


The Octopus and the Orangutan
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The Future In Plain Sight
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The Parrot's Lament
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Silent Partners
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Affluence and Discontent
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The Alms Race
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Apes, Men, & Language
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Biodiversity

THE PROBLEM: Man is recklessly wiping out life on earth
BY EUGENE LINDEN


Monday, Jan. 02, 1989
Before Brazil's great land rush, the emerald rain forests of Rondonia state were an unspoiled showcase for the diversity of life. In this lush territory south of the Amazon, there was hardly a break in the canopy of 200-ft.-tall trees, and virtually every acre was alive with the cacophony of all kinds of insects, birds and monkeys. Then, beginning in the 1970s, came the swarms of settlers, slashing and burning huge swaths through the forest to create roads, towns and fields. They came to enjoy a promised land, but they have merely produced a network of devastation. The soil that supported a rich rain forest is not well suited to corn and other crops, and most of the newcomers can eke out only an impoverished, disease-ridden existence. In the process, they are destroying an ecosystem and the millions of species of plants and animals that live in it. An estimated 20% of Rondonia's forest is gone, and at present rates of destruction it will be totally wiped out within 25 years.

Around the globe, on land and in the sea, the story is much the same. Spurred by poverty, population growth, ill-advised policies and simple greed, humanity is at war with the plants and animals that share its planet. Peter Raven, director of the Missouri Botanical Garden, predicts that during the next three decades man will drive an average of 100 species to extinction every day. Extinction is part of evolution, but the present rate is at least 1,000 times the pace that has prevailed since prehistory.

Even the mass extinctions 65 million years ago that killed off the dinosaurs and countless other species did not significantly affect flowering plants, according to Harvard biologist E.O. Wilson. But these plant species are disappearing now, and people, not comets or volcanoes, are the angels of destruction. Moreover, the earth is suffering the decline of entire ecosystems -- the nurseries of new life-forms. For that reason, Wilson deems this crisis the "death of birth." British ecologist Norman Myers has called it the "greatest single setback to life's abundance and diversity since the first flickerings of life almost 4 billion years ago."

Nearly every habitat is at risk. Forests in the northern hemisphere have fallen to lumbering, development and acid rain. Marine ecosystems around the world are threatened by pollution, overfishing and coastal development. It is in the tropics, though, that the battle to preserve what scientists call biodiversity will be won or lost. Tropical forests cover only 7% of the earth's surface, but they house between 50% and 80% of the planet's species.

But should people in developed countries care about the survival of tropical species never seen outside a rain forest? Yes, they should. Variety is the spice of life, goes the saying. Biologists would go further and argue that variety is the very stuff of life. Life needs diversity because of the interdependencies that link flora and fauna, and because variation within species allows them to adapt to environmental challenges. But even as the world's human population explodes, other life is ebbing from the planet. Humanity is making a risky wager -- that it does not need the great variety of earth's species to survive.

Despite the alarm with which scientists view this trend, biodiversity has just surfaced on the world's political agenda. The troubles of high-profile animals such as the tiger and rhino grab public attention, while most people hardly see the point of worrying about insects or plants. But extinction is the one environmental calamity that is irreversible. As these lowly species disappear unnoticed, they take with them hard-won lessons of survival encoded in their genes over millions of years.

Only 1.7 million of the estimated 5 million to 30 million different life- forms on earth have been cataloged. Since hundreds of thousands of species may be extinct by the year 2000, the world has neither the scientists nor the time to identify the yet uncounted. "It's as though the nations of the world decided to burn their libraries without bothering to see what is in them," said University of Pennsylvania biologist Daniel Janzen at the TIME conference. Harvard's Wilson called this profligacy the "folly" that future generations are least likely to forgive.

Humanity already benefits greatly from the genetic heritage of little-known species. Some 25% of the pharmaceuticals in use in the U.S. today contain ingredients originally derived from wild plants. Hidden anonymously in clumps of vegetation about to be bulldozed or burned might be plants with cures for still unconquered diseases. "I know of three plants with the potential to , treat AIDS," said Janzen. "One grows in an Australian rain forest, one in Panama and one in Costa Rica."

Nature's diversity offers many opportunities for agriculture, especially now that genetic mapping and engineering have given biotechnology firms the potential power to improve crops by transferring genes from wild strains. According to Wilson, biotechnology can transform a plant into a "loose-leaf notebook" from which scientists can select a particular page. Among the possible results: drought- and frost-resistant crops, and natural fertilizers and pesticides.

Diversity is the raw material of earth's wealth, but nature's true creativity lies in the relationships that link various creatures. The coral in a reef or the orchid in a rain forest is part of an ecosystem, a fragile, often delicately balanced conglomeration of supports, checks and balances that integrate life-forms into functioning communities. Given the complex workings of an ecosystem, it is never clear which species, if any, are expendable.

In the tropics the crucial question is how large a forest must be to sustain itself. If a park or protected area is too small to support some of its animal and plant life, the ecosystem will decline even with protection. As yet, no one knows the minimum critical size of a rain forest, but in 1979 Thomas Lovejoy, now at the Smithsonian Institution, set up a 20-year experiment with the cooperation of the Brazilian government to determine just that for the Amazon region. Among the findings: the smaller the forest, the faster the decline of insects, birds and mammals.

Biologists have identified numerous "hot spots" where ecosystems are under attack and large numbers of unique species face an immediate threat of elimination. Among the troubled areas: Madagascar, where more than 90% of the original vegetation has disappeared; the monsoon forests of the Himalayan foothills that are being denuded by villagers in search of firewood, building materials and arable land; New Caledonia, 83% of whose plants occur nowhere else; the eastern slope of the Andes, as well as forests in East Africa, peninsular Malaysia, northeast Australia and along the Atlantic coast of Brazil.

Since less than 5% of the world's tropical forests receive any protection, the stage is set for mass extinctions. Many plants and animals are doomed, no matter what measures are taken. Some researchers estimate that at least 12% of the bird species in the Amazon basin, as well as 15% of the plants in Central and South America, can be counted among what Janzen calls the "living dead." Many tropical mammals and reptiles face only bleak survival under what amounts to house arrest in game parks and zoos.

Why are so many species and environments threatened? The main reason is that throughout the tropics, developing nations are struggling to feed their peoples and raise cash to make payments on international debts. Many countries are chopping down their forests for the sake of timber exports. In Central America forests are giving way to cattle ranches, which supply beef to American fast-food chains. The pressures on forests have led Janzen, who has spent 26 years struggling to save Costa Rica's woodlands, to conclude that "everything outside parks will be gone, and everything inside the parks is threatened."

Efforts to stop the destruction run into moral as well as practical obstacles. How can developed nations demand onerous debt payments and ask the debtors to preserve their forests? How can countries worry about biodiversity when their people are concerned with feeding themselves?

To begin with, the rich nations must reduce the debt burden of the poor. But just as important is a concerted campaign to convince the people of developing countries that it is in their own long-term interest to preserve their environments. Wiping out forests may make developing nations momentarily richer, but it is bound to produce a poorer future.

Experience has shown the Third World that destruction of forests can have disastrous consequences. Forests are vital watersheds that absorb excess moisture and anchor topsoil. Deforestation contributed to the recent droughts in Africa and the devastating mud slides in Rio de Janeiro last year. In Costa Rica topsoil eroded from bald hills has greatly shortened the life of an expensive hydroelectric dam. Alvaro Umana, Costa Rica's Minister of Industry, Energy and Mines, estimated that the surrounding watershed might have been protected 20 years ago for a cost of $5 million. Now the government must reforest the watershed at ten times that price.

Halting the assault on biodiversity will not be easy, but there are many actions that governments can take. First, they should develop and support local scientific institutions that train professionals in conservation techniques. More money should flow into educational programs that alert people to the irreversible consequences of a loss of genetic diversity. An international, environmental version of the Peace Corps could spread conservation expertise to the Third World.

Throughout the developing nations there are encouraging stirrings of local environmental activity. In Malaysia blowgun-armed Penan tribesmen have joined forces with environmentalists in an effort to stop rampant logging. And in Brazil, which has some 500 conservation organizations, environmentalist Jose Pedro de Oliveira Costa organized a coalition of legislators, conservationists, industrialists and media barons to stir public support to preserve Brazil's remaining Atlantic forests. "The threats to the forests remain," said Costa, "but now at least there is a network in place to scream when a threat arises."

But environmental protection must make economic sense, and development must go hand in hand with preservation. Development should be sustainable, meaning that it should use up resources no faster than they can be regenerated by nature. Governments and private firms should organize projects to show that forests can be used without being obliterated. If trees are cut selectively, forests can yield profits and survive to produce more money in the future. Another way to harvest cash from forests and other habitats is to set up tours and safaris to attract animal lovers and photography buffs. Long a moneymaker in Africa and the Galapagos Islands, this "ecotourism" is spreading to such places as Costa Rica.

For sustainable development to work, observed Paulo Nogueira-Neto, environmental adviser to the Brazilian Ministry of Culture, governments will have to devise comprehensive national zoning plans so that their countries can achieve the right mix of preservation and economic growth. Local residents can be encouraged to earn a livelihood in the more robust areas, while habitats that are fragile can be protected. Sustainable development can proceed, noted Kenneth Piddington, director of the environmental department of the World Bank, "right up to a park's boundary."

Financial as well as political leverage can be used in the cause of preservation. Governments should force local lending institutions to review the environmental consequences of proposed loans. No bank, for example, should be allowed to lend a company money to set up a cattle ranch if the operation would destroy too large a section of an endangered forest.

Finally, the unfortunate reality is that many habitats are not going to be , saved. To prevent the genetic legacy of those areas from being extinguished, as many species as possible should be preserved in zoos, botanical gardens and other "gene banks." There, scientists can study a small percentage of threatened organisms and have the options of later returning them to the wild or transplanting some of their genes into other species.

But the best place to preserve the earth's biodiversity is in the ecosystems that gave rise to it. Man must abandon the belief that the natural order is mere stuff to be managed and domesticated, and accept that humans, like other creatures, depend on a web of life that must be disturbed as little as possible.

contact Eugene Linden

Short Take

HOW THE OPTIONS TAIL HAS COME TO WAG THE MARKET DOG: A Simple English Language Explanation of How Structural Changes in the Stock Markets Contribute to Whipsaw Movements in Prices.

Lately a string of violent price movements and reversals in the equity markets make it look like the markets are having a nervous breakdown. The last day of trading in April 2022 saw a 939 point drop in the Dow. The day before that, the Dow rose about 625 points, and two days before that it fell over 800 points. The very next week, after two quiet days, the Dow rose over 900 points after the Fed announced its biggest rate hike in 22 years (ordinarily a big negative for the markets), and then, the next day, fell over 1000 points (more on this later).  There have been plenty of headlines – about the Ukraine Invasion, inflation, the threat of a Fed caused recession, supply chain disruptions – to justify increased uncertainty, but the amplitude of the moves (and the sudden reversals) suggest something more may be at work. Here follows an effort to explain in simple language the significant changes in the market that have contributed to this volatility.

 

“This time it’s different” is perhaps the most dangerous phrase in finance as usually it’s uttered by market cheerleaders just before a bubble bursts. That said, markets do change, and those changes have their impacts. One change in the markets has been the shift from intermediaries (such as brokers) to direct electronic trading, a shift that has made the markets somewhat frictionless, and allowed computer driven funds to do high speed trading. This shift began a couple of decades ago. Today’s markets can move faster than a human can react.

 

Another shift has been the degree to which passive investing through index funds and algorithmic trading through various quant funds have come to eclipse retail investing and dominate trading. A consequence of this is that to some degree it has mooted individual stock picking because when investors move in or out of index funds, the managers have to buy or sell the stocks held on a pro rata basis and not on individual merit. This change too has been developing over recent decades.

 

A more recent and consequential shift, however, has been the explosion in the sale of derivatives, particularly options (the right to buy or sell a stock or index at a specified price on or before a specific date). Between 2019 and the end of 2021, the volume of call options (the right to buy a stock at a specified price on or before a particular date) has roughly doubled. During times of volatility, more and more retail and institutional investors now buy calls or puts rather than the stocks. 

 

Today, trading in options has reached a scale that it affects market moves. A critical factor is the role of the dealers who write options and account for a significant percentage of the options issued. Dealers have been happy to accommodate the growth in option trading by selling calls or puts. This however, makes them essentially short what they have just sold. Normally, this doesn't matter as most options expire out of the money and worthless, leaving the happy dealer to book the premium. Being short options, however, does begin to matter more and more as an option both moves closer to being in the money and closer to expiration. 

 

This situation is more likely to occur when markets make large and fast moves, situations such as we have today given the pile of major uncertainties. Such moves force dealers to hedge their exposure. 

 

Here’s how it works. If, for instance, a dealer has sold puts on an index or a stock, as a put comes closer to being in the money (and closer to expiration), the dealer will hedge his short (writing the put) by selling the underlying stock. This has the combined effect of protecting the dealer -- he's hedged his potential losses – while accelerating the downward pressure on the price. In other words, this hedging is pro-cyclical, meaning that the hedging will accelerate a price move in a particular direction.

 

Traders look at crucial second derivatives of stock prices, referred to by the Greek letters delta and gamma to determine exposure to such squeezes. As an option moves closer to in the money it's delta -- it's price movement relative to the price movement of the underlying, and its gamma -- the rate of change of the delta relative to a one point move in the underlying, both rise. The closer to both the strike price and expiration date, the more the dealer is forced to hedge. The result is what’s called a gamma squeeze. Once the overhang of gamma exposure has been cleared, however, the selling or buying pressure abates, and gamma may flip, with new positioning and hedging done in the opposite direction. The result can be a whipsaw in the larger markets. This same phenomenon can happen with indexes and futures.

 

How do we know that the hedging of option positioning are contributing to violent price changes and reversals in the market? While not conclusive, perhaps the strongest evidence is that large lopsided agglomerations of options at or near the money have been coincident with surprising market moves as expiration dates approach. In fact, some market players use this data to reposition investments, in effect shifting investment strategy from individual companies to the technical structure of the markets. This is what Warren Buffett was referring to when, at his recent annual meeting, he decried the explosion of options and other Wall Street fads as reducing companies to “poker chips” in a casino.

 

The week of the May Fed meeting gave us a real-time example of how a market move that looks insane on the surface reflects the underlying positioning in various derivatives. To set the stage: ordinarily, given debt burdens and the threat of recession, the markets would be expected to react badly to a Fed tightening cycle that is accelerated by the biggest rate hike in 22 years. On Wednesday, however, market indices began to soar on Wednesday when Fed Chairman Powell, one half hour after the Fed announced it 50 basis point raise, suggested that the Fed was not considering larger 75 basis point hikes during this tightening cycle. Traders interpreted this as taking the most hawkish scenario off the table. Up to that point, institutions were extremely bearish in their positioning, heavily weighted to puts on indexes and stocks, and also positioned for future rises in volatility in the markets. Right after Powell made his comments, investors started hedging and unwinding this positioning, and all the pro-cyclical elements entailed in this repositioning kicked in. By the end of the day, the technical pressures producing the squeeze had largely abated, setting the stage for a renewed, procyclical push downward the next day, as the negative aspects of the tightening cycle (and other economic headwinds) came to the fore. 

 

What these violent moves in the market are telling us is that while in the broader sense, this time is not different --the overall sine wave of the market is still that bubbles build and burst -- how the present bubble is bursting may be following a different dynamic than previous episodes. The changes since the great financial crisis-- the rise to dominance of passive trading through indexes and algorithmic trading through various quant strategies – reduced the friction in the markets as well as the value of picking individual companies. Now, the more recent explosion of option issuance, further accelerates market moves, and leads to unpredictable reversals that have to do with option positioning rather than fundamentals such as earnings, politics, or the state of the economy. 

 

The tail (the options and other derivatives markets) now wags the dog (the equities markets).

 

 



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